Why Owning Cash Is More Speculative Than Owning Gold

The question most often asked of gold bulls is, “At what price will you take your profits?” It is a question that betrays a lack of understanding about why anyone should own gold [in the first pace but,] nevertheless, the simple answer must be, “When paper money stops losing its value”. This response should alert anyone who asks this question to the idea that owning fiat cash is the speculative position, not ownership of [gold and silver].

So says Alasdair Macleod (www.FinanceAndEconomics.org) in an article* which Lorimer Wilson, editor ofwww.munKNEE.com, has reformatted and edited […] below for the sake of clarity and brevity to ensure a fast and easy read. (Please note that this paragraph must be included in any article re-posting to avoid copyright infringement.) Macleod goes on to say:

Owning Cash is More Speculative Than Owning Gold – Not the Other Way Around

This sums up the problem. Instead of gold, people commonly think of paper money as the only medium of exchange and as a store of value; cash is after all their unit of account. They see the gold price rising when they should be seeing the value of paper money falling. Because cash is everyone’s unit of account it is wrongly seen as the ultimate risk-free asset. This is also the fund manager’s approach to investment: his/her investment returns are calculated in paper money, so she/he cannot account for a superior class of asset. He/she is also taught to spread investment risk across a range of inferior asset classes to enhance returns. Therefore the investment manager wrongly assumes that precious metals [i.e. gold and silver] is one of those inferior asset classes. All modern investment management works on these assumptions.

[The above] helps explains why managed portfolios today have very little exposure to gold and/or silver, but there are other reasons [as well]. Investment funds in total have grown rapidly since the 1970s on the back of money and credit creation. This monetary expansion has fuelled both new funds for investment as well as asset prices generally, while gold and related investments became unfashionable [during the] twenty year bear market in gold between 1980 and 2000. The combination of these two factors reduced the exposure of gold and silver in managed portfolios to very low levels. Gold was therefore ignored as an asset class when modern portfolio theory evolved in the 1990s, and gold is simply not considered by the current generation of fund managers.

Consequently, investment funds of all types invest in bond markets, stock markets, property assets, securitisations, foreign currencies and to a minor extent [in] general commodities. From time to time they may have had temporary and speculative exposure to gold, but very few fund managers actually understand that gold is the ultimate hedge against cash losing its value. After all, if you account in paper money, paper money has to be the risk-free position. The understanding that cash is not risk free is left to private individuals not misinformed by modern portfolio practice.

Private Individuals Now Beginning to Hoard Gold and Silver

The world-wide accumulation of hoarded wealth in the form of gold and silver ingots, coins and jewellery has been growing at an accelerating rate over the last thirty years. This has compromised the central banks who were actively suppressing the price: the result is that large amounts of gold and silver have passed from governments to private individuals. None of this can be properly captured in the statistics, partly because the central banks involved refuse to provide accurate information about their sales, swaps and leases, and partly because the individuals that hoard gold and silver do so secretly, and are therefore beyond the scope of meaningful statistics.

The reason individuals hoard precious metals is the basic hypothesis of this article: they will dishoard gold when paper money stops losing its value. We should therefore consider the extent and speed of this loss. In 1973 there were US$1,120 of demand deposits plus cash currency for every ounce of gold owned by the US government. Today, including excess reserves held at the Fed and the $600bn to be printed over the next seven months, the figure stands at $26,512. In 1973 there were twelve times as many dollars as there was gold at the market price, compared with nearly 20 times today, so paper dollars are more overvalued in gold terms today than at the time when the gold price was only $100.

A Banking Collapse is Inevitable

The quantity of paper money will continue to grow as the world wrestles with its problems. As every day passes, one’s worst fears of yesterday materialise. Governments, driven by social pressures rather than dispassionate economics, are forced into ever-increasing financial rescues; but by far the biggest problem facing them is the seeming inevitability of a full-scale banking collapse.

That is what has the panjandrums of Euroland in a panic over Ireland. We are told by the Bank for International Settlements that total Irish debt to foreign investors stands at $791bn, the substantial majority of which is owed by the banking sector. Ireland on its own might not derail European banks, but the domino effect of the spreading problem most probably will.

A banking collapse, obviously, cannot be allowed to happen. Forget the rights and wrongs of “too big to fail”: politicians and therefore central banks have no option but to intervene – but what can they do? They cannot fund a rescue with taxes, and they are already borrowing as much as the bond markets can stand. There is only the nuclear option left, however it is dressed up: shore up the system by printing as much money as it takes. Printing money is simply the way governments buy time.

Gold Will Continue to Rise With Continued Acceleration in Printing of Fiat Currencies

This analysis may turn out to be unfortunately right, or hopefully wrong; but it is more right today than it was last month and also progressively so for the months before that. The rising interest in gold and silver is entirely consistent with the growing likelihood that the printing of fiat currencies will continue to accelerate in order to buy off default. While the translation of monetary inflation into price inflation is rarely an even result, we know from both economics and the experience of history that the two are linked as cause and effect respectively. So we can conclude that paper money will continue to lose its value for the foreseeable future.

Accelerating price inflation, however, does not just affect cash as an asset class:

a) Bonds, which are commonly the largest component of a conventional portfolio, will lose value faster than cash.

b) Equities will be lucky to keep up with cash values while bond yields rise and the adverse effects of accelerating inflation result in recession.

c) Property will be hit by rising bond yields and rent increases that can only lag inflation.

d) Only commodities, which are a minor asset class for portfolios, can be reasonably expected to outperform cash…

e) History confirms that gold and silver are easily the best performers in times of rising inflation.

Conclusion

In the middle of today’s banking and economic crisis those unfortunates who have delegated the management of their investments to professional fund managers have only bought for themselves the illusion of financial security. They are almost entirely exposed to cash and assets that are dependant on cash itself, because they own negligible amounts of gold and related investments. This means that systemically, portfolios have become totally dependent on the stability of fiat currencies.

Paper money may be the medium of exchange and the unit of account, but in these increasingly uncertain times gold and silver are the safest stores of value and will continue to be hoarded, irrespective of price, for as long as these uncertain times continue.

Gold and silver, not cash, are the ultimate risk-free investment class.